Chris Johns: ‘Capitalism might not be dead but it is totally rigged’

The flicker of economic growth has stemmed the populist tide for now but for how long?

Bertie Ahern probably still thinks the financial crisis was all down to Lehman Brothers

Bertie Ahern probably still thinks the financial crisis was all down to Lehman Brothers

 

Some Marxists think that capitalism died 10 years ago this month when a couple of obscure hedge funds blew up, generating few headlines outside the financial press. What happened next did attract more publicity: the Great Financial Crisis (GFC).

Some believe it was all about US sub-prime mortgages; Bertie Ahern probably still thinks it was all down to Lehman Brothers. Most sensible analysts think it was all a bit more complicated than that.

The problem was – and still is – leverage. Polonius was one of many characters – real and fictional – throughout history to warn about about borrowing and lending. The real lesson is bit more subtle: don’t borrow (or lend) too much.

Polonius, in Hamlet, was advising his son never to lend anything at all to a friend since both your cash and your friendship are at risk.

The lessons of the GFC are that some borrowing is good but too much is bad: not only are the borrowed funds at risk, but, once they hit a certain size, whole economies are imperilled.

It would have been better if bankers had in fact lent to their friends since that might have provided knowledge, a few clues, as to whether or not the borrower was ever likely to be able to pay back the money.

It’s not that capitalism is dead; rather that it is totally rigged. The GFC revealed this simple fact to pretty much everybody. Most obviously, no accountability was ever apportioned: few were arrested or jailed.

Banks are still too big too fail and don’t have enough capital to protect themselves from the next set of bone-headed lending decisions. Banks should not be giving money back to shareholders already via dividends and buys-backs.

Capitalism is prone to periodic crises precisely because of over-borrowing: we don’t know when the next crisis will hit, or the form the excess debt will take, but the crisis is on the way. We can only hope that it still far in the future.

Capitalism is rigged in all sorts of other ways, of course. The GFC didn’t cause or even increase global income and wealth inequality. For a short while it actually achieved the reverse thanks to the destruction of financial and property wealth that most impacted, albeit temporarily, those rich people who tend to own stuff.

But the crisis did help to expose, or at least was accompanied by, a growing realisation that globalisation has a dark side: there are losers as well as winners.

Some economists didn’t think another global depression was even possible, let alone likely. The most popular criticism made of economists was that they didn’t forecast the GFC. This is almost beside the point.

Paul Krugman makes the rather deeper argument that mainstream economics has been hijacked by those who sought “beauty rather than truth”. This is an ongoing row within the profession between those who think mathematical elegance is sufficient unto itself and those who believe that mathematical modelling has become a fetish that gets in the way of sensible policy advice.

From the sidelines we can observe the pure politics lurking within this debate: the mathematicians are mostly all free-market, small state, right-wingers while their critics are those who describe themselves as “progressive” – they argue government intervention is a good thing. It is all, of course, very old wine in new bottles.

Gaps in our knowledge were starkly revealed by the GFC. Our models didn’t adequately deal with borrowing and lending.

Academics have paid little attention to the significance of very large economic actors (asset managers) who take huge decisions on behalf of other people (it’s called a principal-agent problem).

Capitalism has become even more rigged via the trillions of euro now invested in companies passively: the rise of low-cost index funds. This is great for anyone seeking low cost investing. And, a bit like leverage, some of it is undoubtedly a good thing. But, like borrowing, too much can be dangerous.

Money is invested in companies in a totally dumb fashion: few people bother to check whether the investment was wisely made or whether the recipients of the cash were good stewards of other people’s money.

Companies receive cash and then rarely have to answer to investors. Even more worrying, when cash is sprayed at the whole stock market – that’s what passive index investing means – the pressure for companies to compete, to become better at what they do, is reduced.

If I’m invested in every company in the market why would I want one business to do better at the expense of another? I suspect that one aspect of the low productivity growth mystery (economies have grown way too slowly since the GFC) is to be found here.

The GFC contributed to growing awareness that the system is rigged. Capitalism is a winner–takes–all game with increasingly fewer winners of ever bigger jackpots. That’s why we have Trump and Brexit and Neymar.

The flicker of economic growth in Europe has stemmed the populist tide for now but for how long? Until the next crisis, then.

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